Plethora of distressed plants on market puts industry-structure question on table

POWER - 02/19/2004

While depressed generating asset values were the overarching concern expressed by industry executives at Cambridge Energy Research Associates' annual executive conference in Houston last week, most of the discussion focused on the role load-serving entities may ultimately play in the asset reshuffling that is under way.

The "merchant generating model" in the U.S. has been so ravaged financially that it may not be salvageable, and federal regulators may have to consider ending their support of the industry and letting utilities buy more of the distressed generating capacity, industry officials and financial analysts said at the meeting last Thursday.

Cinergy President and CEO James Rogers said some state regulators, looking to increase reserve generating capacity, are asking regulated utilities to look at buying existing units as a lower-cost alternative to building plants.

"That's where the tension is now. That's where the state-federal jurisdictional struggle is," he said.

At the end of the day, Rogers said, "state commissions have to guarantee reliability" and they "want to assure there is adequate capacity."

"When regulators want new plants, I give them new plants." But, he said, "I think a judge, at the end of the day, would determine that state PUCs have the jurisdiction. We are on a collision course. The federal government shouldn't dictate."

The question is whether regulated utilities should be allowed to buy merchant units and bring them back into rate base.

The Federal Energy Regulatory Commission, which warned Duke in recent days against selling its merchant facilities in the Southeast to any load-serving entity, is hoping to reinvigorate wholesale electricity competition and has been reluctant to approve requests by utilities to either buy merchant plants in their service territories or sign power-purchase agreements with affiliated companies.

FERC Commissioner Nora Brownell, also speaking at the CERA meeting, said she does not want to see the power industry return to its vertically integrated past. "We want the stability of the regulatory model, but once the market picks up, it is not necessary to stay in that model," she said. "There should still be room for independent power producers... We can make sure investors take the risks and not ratepayers."

Nonetheless, as prices for hard-pressed merchant plants decline further, "it will be compelling for state commissions to encourage [utilities] to buy rather than build," argued Jacob Worenklein, president and CEO of U.S. Power Generating.

Said AES President and CEO Paul Hanrahan, "No one in their right mind is going to build a merchant unit today."

In a recent report, ABN AMRO estimated that there are roughly 56,000 MW of generating capacity currently for sale in the U.S. Some 33,000 MW of that is classified as "distressed merchant," while the remaining is qualifying facility power or "other facilities" that benefit from power purchase agreements.

While hedge funds and some investment banks have bought cogeneration facilities and QFs over the past year, they have been attracted mainly by long-term contracts associated with such units. No strategic investors or financial institutions are today looking at buying distressed merchant assets that do not have long-term supply deals, argued Worenklein.

In the past 14 months, four companies that defaulted on loans have turned over to their bankers some 15 merchant units in seven states with a total capacity of 14,154 MW. The four companies, TECO, Exelon, NRG and the former PG&E NEG, turned the units over to the lead banks of large lending syndicates.

Citibank now has or will soon own 4,150 MW, while Societe Generale will hold 5,550 MW. BNP Paribas, which has assumed Exelon's six Boston Generating units, has 3,400 MW. ABN AMRO is holding NRG's 633-MW Brazos Valley Energy unit in Texas.

Mayo Shattuck, chairman, president and CEO of Constellation Energy and a former chairman of Deutsche Banc Alex. Brown, said he expected the banks now will "sit on" those assets, perhaps for years, as they recover their investments. Shattuck noted, for example, that banks who repossess certain real estate properties have the accounting means at hand to hold on to those properties "for decades," waiting for buyers.

"The banks don't want to write off the assets," said Rogers, who said he expected to compete against Constellation for the business of operating the units. "We have had one or two opportunities from the banks, to either supply gas or sell power, but nothing more thus far."

"I thought there would be a more rapid evolution of a business to run those plants for the banks," Shattuck said. "But it hasn't yet materialized." He said the size of the syndicates, and the complexity of the ownership of the plants, has slowed the process.

John Bryson, Edison International chairman and CEO, said he expected FERC to rule Feb. 23 on his utility's proposal to create a wholly owned subsidiary to buy and complete the unfinished 1,054-MW Mountainview merchant plant and sell the power back to it under a 30-year contract.

The proposal, which has won approval from state regulators, has drawn sharp criticism from merchant generators, who charge that the plan would harm wholesale competition and argue that SoCal Ed should be required to test the market to determine whether lower-cost alternatives are available.

SoCal Ed needs a FERC decision before Feb. 29, when its option to buy the plant from InterGen expires. Bryson said other than the Mountainview project, SoCal Ed plans to concentrate on securing long-term contracts and to buy less power in the more volatile spot market.

AES' Hanrahan, who noted that AES had once owned the Mountainview facility, said he believed the price of a merchant unit that owners want and what people are willing to pay for it is "converging," but the gap has not closed completely.

Deals won't close, he said, until asset owners acknowledge that the values of their plants have been deeply discounted by the market. Ironically, while most other regions are concerned with excess capacity, California, according to Bryson, should be very worried about a looming shortfall. Bryson was effusive on the issue last week. He warned that while California has made progress in resolving its energy problems since the crisis of 2000-2001, state officials need to realize that there is a very real possibility of severe supply shortages reoccurring as early as 2006.

Saying the state is now in the "calm before the storm," Bryson said officials have yet to develop a framework or establish "clarity" about how electricity will and should be provided, what obligations utilities will have and the role of competitive markets.

The uncertainty, he said, has left the state facing "a situation in which investment is largely not being made in generation facilities."